Thursday, November 7, 2013

Rothbard’s Clueless Statements on Costs of Production and Price

They can be read here:

“What are the costs involved in the decisions made by the owners of the factors? In the first place, it must be stressed that these costs are subjective and cannot be precisely determined by out­side observers or be gauged ex post by observing accountants. Secondly, it is clear that, since such factors as land and the produced capital goods have only one use, namely, the production of this product (by virtue of being purely specific), they involve no cost to their owner in being used in production. By the very terms of our problem, the only alternative for their owner would be to let the land lie unused, earning no return. The use of labor, however, does have a cost, in accordance with the value of the leisure forgone by the laborers. This value is, of course, unmeasurable in money terms, and necessarily differs for each indi­vidual, since there can be no comparison between the value scales of two or more persons.

Once the final product has been produced, the analysis of the previous chapter follows, and it becomes clear that, in most cases, the sale of the good at the market price, whatever the price may be, is costless, except for rare cases of direct consumption by the producer or in cases of anticipation of a price increase in the near future. This sale is costless from the proper point of view – the point of view of acting man at the relevant instant of action. The fact that he would not have engaged in the labor at all if he had known in advance of the present price might indicate a deplorable instance of poor judgment, but it does not affect the present situation. At present, with all the labor already ex­erted and the product finished, the original – subjective – cost has already been incurred and vanished with the original making of the decision. At present, there is no alternative to the sale of the good at the market price, and therefore the sale is costless.

It is evident, therefore, that once the product has been made, ‘cost’ has no influence on the price of the product. Past costs, being ephemeral, are irrelevant to present determination of prices. The agitation that often takes place over sales ‘below cost’ is now placed in its proper perspective. It is obvious that, in the relevant sense of ‘cost,’ no such sales can take place. The sale of an already produced good is likely to be costless, and if it is not, and price is below its costs, then the seller will hold on to the good rather than make the sale.

That costs do have an influence in production is not denied by anyone. However, the influence is not directly on the price, but on the amount that will be produced or, more specifically, on the degree to which factors will be used. We have seen in our example that land and capital goods will be used to the fullest extent practicable, since there is no return or benefit in allowing them to remain idle. But man laboring bears the cost of leisure forgone. What he expects will be the monetary return from his labor is the deciding factor in his decision concerning how much or whether or not to employ his labor on the product. The monetary return is ranked on his subjective value scale along with the costs of forgoing leisure, and his decision is made on the quantity of labor he will put forth in production. The height of costs on individual value scales, then, is one of the determinants of the quantity, the stock, that will be produced. This stock, of course, later plays a role in the determination of market price, since stock is evaluated by consumers according to the law of diminishing marginal utility. This, however, is a far cry from stating that cost either determines, or is co-ordinate with utility in determining, price. We may briefly summarize the law of price (which can be stated at this point only in regard to specific factors and joint ownership, but which will be later seen as true for any arrangement of production): Individuals, on their value scales, evaluate a given stock of goods according to their utilities, setting the prices of consumers’ goods; the stock is produced ac­cording to previous decisions by producers, who had weighed on their value scales the expected monetary revenue from consumers against the subjective costs (themselves simply utilities forgone) of engaging in the production. In the former case, the utility valuations are generally (though by no means always) the ones made by consumers; in the latter case, they are made by producers. But it is clear that the determinants of price are only the subjective utilities of individuals in valuing given conditions and alternatives. There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price.” (Rothbard 2009: 341–343).

The first part of this quotation uses a purely subjective definition of “costs,” which appears to deny that monetary costs of production are what Rothbard has in mind.

Yet, by the end of the passage, Rothbard advances to a gross non sequitur, where he moves to a different “objective” definition of costs that must include monetary costs of production:

“But it is clear that the determinants of price are only the subjective utilities of individuals in valuing given conditions and alternatives. There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price.” .

This, as anyone familiar with real world capitalist economies would know, is completely and utterly contradicted by the empirical evidence on administered prices.

Depending on the particular nation involved, administered prices – or mark-up prices – tend make up between 50% and 70% of prices in modern market economies. The administered price is quite clearly determined by average costs of production per unit plus a profit mark-up.

Rothbard’s view of costs and prices is clueless, ignorant, and wrong.

Nor is Rothbard alone in this spectacular error. Here is the Austrian Thomas C. Taylor:

“The individual seller’s costs were shown to relate to his subjective scale of values – that is, to his own valuation of the good in its next best alternative use of either direct use or future sale. Once the goods have been produced, his past money costs are irrelevant to deciding how to use these goods. As Thirlby has said, ‘Cost is ephemeral. The cost involved in a particular decision loses its significance with the making of a decision because the decision displaces the alternative course of action.’ Jevons stressed the same truth when he stated, ‘In commerce bygones are forever bygones and we are always starting clear at each moment, judging the value of things with a view to future utility. Industry is essentially prospective not retrospective.[’] The seller’s task is to make the best of his situation in light of his possessing a certain stock of goods. Thus it is not correct to say that prices are determined by demand and by money costs. Money costs enter into the seller’s decisions about the undertaking of production. … Once the goods are produced, only subjective valuations expressed by individual buyers and sellers relating to these goods and to their exchange ratios in money terms are effective in the establishment of market prices.” (Taylor 1980: 59–60).

Austrian price theory, as least as it stands in these authors, has precious little relevance to the real world.

29 comments:

On this occasion it may be your reading of Rothbard that is clueless rather what he actually wrote.

As has been pointed out many times - in Austrian models there is a tendency for prices to equal cost of production plus a mark up for profit (just like in Post-Keynsian models.).

As far as I can see however Post-Keynesian models don't really explain where either the "costs" or the "markup" used in cost+markup prices actually come from. Austrian models , based on subjective valuations, have no trouble explaining either. The excerpt from Rotbard is a pretty good example of the Austrian way of thinking about these things and certainly not clueless even if you disagree with it.

I don't really have time to go through it any detail but here is an example of your mis-interpretation.

Rothbards says:

"There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price.”

And you think you are showing this to be clueless by referring to empirical evidence that up to 70% of business use fix-price models. But surely you would accept that if a business produced a good that did not meet a market need and tried to sell it at cost+markup it would find no takers and would eventually have to sell it at a loss or just abandon it ? Surely this fact alone must tell you that underlying cost+markup there still must be a concept of "subjective valuations" both by businesses in deciding what to produce and consumers deciding what to consume.

I challenge you to describe a viable model where subjective valuations don't play a key tole. Post-Keyensian models have just hidden this away in implicit assumptions.

(1) in Austrian models there is a tendency for prices to equal cost of production plus a mark up for profit

Rob Rawlings, you are simply wrong.

Cite me WHERE there are the modern Austrian models that say modern market economies have many prices set by average costs of production "plus a mark up for profit".

And do not cite Ludwig Lachmann, because all he did was cite Keynesian and Post Keynesian literature and then criticise his fellow Austrians for not understanding administered prices: in fact, he says plainly that they do not understand it and their price theory is badly deficient.

You can point to some old work by Wieser or Eugen von Böhm-Bawerk where costs of production are said to be an important element in price, but even here it is generally marginal cost, not average costs per unit, that are invoked as the cost of production, and I do not recall either of them talking of profit mark-ups.

Fundamentally, neither Wieser nor Eugen von Böhm-Bawerk is used by modern Austrians in their price theory. Reismann mentions them briefly in a few pages, but this single brief mention does not support your statement that in "Austrian *models* there is a tendency for prices to equal cost of production plus a mark up for profit ".

(2) "As far as I can see however Post-Keynesian models don't really explain where either the "costs" or the "markup" used in cost+markup prices actually come from. Austrian models , based on subjective valuations, .... But surely you would accept that if a business produced a good that did not meet a market need and tried to sell it at cost+markup it would find no takers and would eventually have to sell it at a loss or just abandon it ?"

You are ignorant indeed if think Post Keynesians deny that people must subjectively value a good before they buy it.

Of course they do. This ISN'T denied by Post Keynesians. Nor is it inconsistent with administered price theory. Nor does it refute it in any way.

But just because people must subjectively value a good first before attempting to buy it, it does not follow "only subjective valuations expressed by individual buyers and sellers relating to these goods and to their exchange ratios in money terms are effective in the establishment of market prices."

Rothbard's statement that "There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price” is utterly wrong.

Furthermore, I have just looked at George Reisman's Capitalism: A Treatise on Economics (1996).

Administered prices are mentioned on p. 417 and then dismissed. Reisman never presents any serious administered price "model" nor develops the implications of administered prices.

As far as I am aware, there is nothing in Mises, Hayek, Rothbard, Kirzner or other Austrian economists on administered prices. There are no "Austrian models" where "there is a tendency for prices to equal cost of production plus a mark up for profit."

And again if we look at Friedrich von Wieser's Natural Value (trans. Christian A. Malloch; London and New York, 1893), p. 171ff. there is nothing there about administered prices -- meaning prices based on average costs of production per unit plus profit mark-up. Nothing.

Wieser's "law of costs" is marginalist analysis through and through:

Whether too much or too little has been produced is seen exactly in the value. If the value of products – as it results from the equation between supply and demand – is less than that of the costs, too much has been produced; the costs which should have brought forth products having higher value have brought forth only goods having less value. Where the value of the product exceeds that of the costs, too little has been produced – with one exception which will be mentioned shortly; – the costs have not been employed entirely in bringing forth products of the highest value – the very anticipation of which gave the costs their value. If products, then, are to be produced neither over nor under cost they must be produced exactly at cost value, if they are to find the most economically advantageous distribution of production.

If we ask why products thus produced – neither under nor over costs – have value, and why they have definite amounts of value, we shall doubtless find that they have themselves alone to thank for it. They create it out of their utility, taking into consideration the amounts produced. The circumstance that costs of a certain value have been expended in making them, is of no consequence as regards their value. The cost value does not determine the use value; the use value exists of itself, and sanctions the cost value.pp. 176-177.

So you cannot cite Wieser for the claim that there are "Austrian models" where "there is a tendency for prices to equal cost of production plus a mark up for profit".

His theory of interest posits that the spread between input prices and output prices will tend towards the originary rate of interest (itself based upon time preference). What else can this mean other than prices will equal costs + markup ? (The mark-up being determined by the rate of interest). Its much more explicit in Bohm-Bawerk but it is there in Rothbard too.

On ""There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price”". I'm glad that you clarify that subjective valaution do play a role in fixprce theory.. But once you have conceded that you are on a path takes you all the way to Rothbards statement. The "costs" that are used in cost+markup are ultimately subjectively and not objectively determined. Again I challenge you to show me a model where this is not the case. I don't think this is particularly damaging to PK theory by the way - acceptance of this would actual provide a better foundation IMO.

(1) "His theory of interest posits that the spread between input prices and output prices will tend towards the originary rate of interest (itself based upon time preference). What else can this mean other than prices will equal costs + markup ? "

That is not a Post Keynesian administered price theory at all, but marginalist analysis, and moreover just another fantasy world theory requiring fictitious convergence to equilibrium states. The "originary rate of interest" is as worthless as Wicksell's natural rate of interest.

Your "mark-up" is not the real world profit markup of businesses, which is not even necessarily dependent on interest rates at all, since production might be financed by retained earnings. The "costs of production" look like marginal cost, not average costs of production per unit.

(2) " But once you have conceded that you are on a path takes you all the way to Rothbards statement.

No, it doesn't. See (1.)

(3) "The "costs" that are used in cost+markup are ultimately subjectively and not objectively determined.

That is plain codswallop, rob. Of course they are determined objectively: by money prices.

"That is not a Post Keynesian administered price theory at all, but marginalist analysis"

Exactly. My whole point is that Austrian marginlists come to the same conclusions at Post-Keynsians. The fact that you don't like theories based on the originary rate of interest does not alter the reality that Austrian models that use them come to (in effect) to price+markup conclusions - which is all I claimed.

If you think prices are set objectively then please explain how the price of skilled labor is set if not in reference to how people value its product ? BTW: Subjective price theory obviously also uses money prices so that is not much of an answer.

'Your only response is to use a fallacy of equivocation where "markup" and "costs of production" are simply redefined'

I am using "price" , "costs of production" and "mark-up" in a perfectly standard way in describing each model. Can you clarify what you mean ?

"average costs of production per unit as measured by money prices" is simply an accounting concept that has no bearing on how those costs are derived. You never answered my question on how the price of skilled labor is so derived.

""average costs of production per unit as measured by money prices" is simply an accounting concept that has no bearing on how those costs are derived."

This bizarre statement -- which iis plainly wrong -- simply reinforces your inability to argue and loss of this argument.

E.g.,:

“For several years a group of economists in Oxford have been studying problems connected with the trade cycle. Among the methods adopted is that of discussion with business men, a number of whom have been kind enough to submit to questioning ... about the policy adopted in fixing the prices and the output of products.”

An overwhelming majority of the entrepreneurs thought that a price based on full average cost (including a conventional allowance for profit) was the ‘right’ price, the one which ‘ought’ to be charged. In some cases this meant computing the full cost of a ‘given’ commodity, and charging a price equal to cost. In others it meant working from some traditional or convenient price, which had been proved acceptable to consumers, and adjusting the quality of the article until its full cost equalled the ‘given’ price. A large majority of the entrepreneurs explained that they did actually charge the ‘full cost’ price ..."

Yet according to you, "average costs of production per unit ... has no bearing on how those costs are derived".

Your quote explains how prices may be derived. Nowhere does it explain how costs are derived - which is what we are discussing. You have yet to explain how "objective costing" works. And you STILL didn't answer my question on how the price of skilled labor is derived.

(1) Of course that quote can explain how some costs of factors of production can be determined.

Why? Because even factor inputs like capital goods (such as durable manufactured capital goods) can have administered prices.

Factor input goods -- like consumer goods -- can be divided into (1) flexprice and (2) fixprice markets. To the extent the costs of some factors are flexprice and demand curves well behaved, of course conventional analysis has some merit. But then some capital goods will be fixprice and governed by administered price setting.

(2) wages of skilled labour can be determined by many factors in varying degrees, from institutional factors, collective bargaining, trade unions, minimum wage laws, demand and supply, and so on.

So back to the original issue: You think when Rothbard says 'There are no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price.' you think this is clueless.

I assume this is because you think that when a business uses price+markup as a policy it is using already given values , which you deem objective, and that this proves Rothbard wrong?

I think that is simplistic.

All manufacturing process use a combination of existing goods and original factors (such as labor). You have listed all the factors that determines the price of labor and non of them are objective. So any business that uses cost+markup has at least some direct inputs whose price is based on non-objective factors.

You may think that this leads to the conclusion that prices are based on a combination of objective and non-objective factors. However ultimately all goods are made from production process that can be traced back to original factors alone, whose prices are non-objectively derived.

So all costs in the cost+markup model. if traced backwards far enough will lead to prices that are derived non-objectively.

Therefore: Rothbard's statement is true. There are indeed 'no ‘objective’ or ‘real’ costs that determine, or are co-ordinate in determining, price'

I guessed you would respond by just defining "objective" in such a way that makes your argument true. (though I thought you might find something a bit better than just deeming any money price "objective").

Of course Rothbard could do the same thing (were he not dead) so probably no point pursuing this further.

I have not "defined" or "re-defined" the word "objective" to win this argument.

I use the standard definitions.

Money prices are objective. The money price of a good for sale is not subjective: it is not just dependent on your state of mind and changeable just because you think so.

Two people can't disagree abut a money price without one of them being wrong.

In contrast, two people can disagree about whether a painting is beautiful with both of them being right, because beauty is indeed subjective.

And in this case even Austrians -- including Mises -- agree that money prices are objective:

In order for the owner of the automobile factory (and other producers) to accurately envision the tradeoffs of different production decisions, he needs to know the objective exchange value of the various cars he could manufacture. It's not enough that the car producer knows that he values yachts and steak dinners; he also needs to know how much money he can raise by selling different models of his cars, and how much money he will need to spend if he wants to acquire yachts and steak dinners. ....

The one essential difference with money is that it has no subjective use-value, which could ultimately explain its objective exchange value.Murphy, Robert P., Theory of Money and Credit Study Guide, p. 61.

That is, the price of a good is an objective economic value. This is an Austrian idea.

But I expect that all these Austrians have just re-defined "objective" too have they, rob?

"The central element in the economic problem of money is the objective exchange value of money, popularly called its purchasing power. This is the necessary starting point of all discussion; for it is only in connection with its objective exchange value that those peculiar properties of money that have differentiated it from commodities are conspicuous. Ludwig von Mises, The Theory of Money and Credit, p. 97.

You are still playing with worlds LK. You have jumped on a lack of clarity in my last comment and now present a huge red herring rather than addressing the real issue we are discussing which is the derivation of prices/costs.

Your quotes are about the Austrian view that prices are objective facts from the perspective of economic calculations. However Rothbard's quote is clearly not about that aspect of prices but about the underlying subjective valuations that drive costs and prices to those particular values. In his model this is based on marginal utility analysis and in yours by socially driven things like minimum-wage legislation, conventions, (and even a bit of supply and demand).

It is your definition of these things as "objective" that I was highlighting. I accept that some of things are probably exogenous to your model but that is not the same as objective. In both your model and Rothbard's costs are ultimately based on non-objective things (defining objective to mean something like "not influenced by personal feelings").

Rothbard is not saying that real objective costs as money prices cannot exist in that statement, but that they do not determine price, because he thinks prices are determined by intersection of demand and supply curves and flexible adjustment of prices in trades between buyers and sellers.

Rothbard is denying full cost and mark-up pricing, and he is wrong and ridiculously wrong at that.

It may be even worse than that. Consider selling an insurance policy. Cost sets a lower bound for the price, and this is pretty absolute because the cost has not been incurred yet. There are no sunk costs associated with the assumption of the risk. The risk will not be assumed without a minimum return on investment. This will be normally indicated as a markup on the projected cost.

"Rothbard is not saying that real objective costs as money prices cannot exist in that statement, but that they do not determine price, because he thinks prices are determined by intersection of demand and supply curves and flexible adjustment of prices in trades between buyers and sellers. :"

This is a correct. Just not sure how you jump from that to:

"Rothbard is denying full cost and mark-up pricing, and he is wrong and ridiculously wrong at that."

Of course he probably would have denied that (he is an Austrian marginalist!) - but why does that make him "wrong and ridiculously wrong at that." ? Nothing you have said in this discussion justifies that statement. .